Despite patchy political and policy support for renewables over the last decade, the UK’s Contracts for Difference (CfD) system has been a resounding success.
The most recent fourth allocation round (AR4) scheme – branded by government as “the most successful ever” – secured nearly 11GW of capacity spanning offshore wind, solar, and saw the inclusion of floating offshore wind and tidal stream for the first time.
The next round – AR5 – opens this March and will mark the first annual auction since the scheme’s inception. However, it will be held in a vastly different economic and political landscape to those before.
Not only is energy security now the guiding principle in any discussion of new procurement, but skyrocketing prices, inflation and supply chain pressures are all likely to have a pronounced impact on the strategy – and ultimately the price – developers are willing to pay.
The levelised cost of energy (LCOE) in the power sector has increased by 20% over the past 12 months, according to clean energy trade bodies, a movement which could have a major impact on planned capacity in the years to come.
As market analysts Cornwall Insight noted in a recent blog: “A combination of market drivers, inflation and geopolitics have meant that capital costs have increased in the last year to 18 months. With assets competing for contracts two or three years before delivery, this increased uncertainty in asset costs could impact prices.”
Legal sources reached by Energy Voice suggested there was a widespread understanding in the market, and in the UK Government’s energy department, that the record bids in AR4 were probably not reflective of the current market environment.
As a result, AR5 could be the first round in which we see renewables prices go up, and not down.
“This idea is reinforced by evidence from other markets, with the latest Spanish subsidy auction not obtaining any solar bids, whilst the German subsidy scheme sees continued underbidding and lack of engagement,” noted Cornwall analysts.
“The trend of lowering strike prices and maximum participation for optimum outcomes should not, therefore, be presumed to continue.”
Going to Pot
Other dynamics are also likely to prompt a shift. AR5 will see fixed-bottom offshore wind moved into “Pot 1” meaning it will – for the first time – compete directly with established and potentially cheaper technologies like solar and onshore wind.
Moreover, administrative strike prices put offshore wind at among the most competitive in that pot – £44/MWh – compared with £47 for solar and £53 for onshore wind.
This may enable “greater competition and dampen submitted prices” the analysts suggested, though with other parameters such as the overall budget and capacity limits yet to be disclosed, a great deal remains unknown.
Meanwhile in Pot 2, a greater focus on energy security could see more emergent technologies including floating wind, wave, geothermal and tidal shunned.
A campaign by Scottish politicians saw ringfenced support of £20m per year offered for tidal stream projects in AR4, in a bid to help the fledging sector commercialise. The government has yet to confirm whether the same support will be offered in AR5, though dedicated geothermal support has been mooted too.
Levy dries up
Market interventions outside of the CfD process are also likely to cast a long shadow.
Applicable from the start of this year, the Electricity Generator Levy proposed in the Autumn Budget adds a temporary 45% levy on electricity sold above £75MWh. Combined with corporation tax, it brings the cumulative rate on earnings over £75Mwh to 70%.
While the levy explicitly does not apply to electricity generated under CfDs it is likely to affect other areas of developers’ business, and could limit their ability to split projects between both merchant and CfD supply models.
Cornwall also points to wider market reforms, including the outcomes of the Review of Electricity Market Arrangements (REMA), which could bring fundamental changes to the power sector and inject a further degree of uncertainty into this year’s CfD process.
The possibility of a move to new mechanisms such as locational marginal pricing (LMP) could have a radical impact on the cost of power and transmission, again leading to more conservative bidding strategies.
Though much is yet to be determined, renewables groups have made clear their demand for greater support in the coming budget.
Faced with more taxes and increasing competition for capital amid a global race to net zero, British trade bodies including RenewableUK warned government last month warned that the UK’s competitiveness as an investment destination for clean energy is at “severe risk”, and that investment in renewables and supply chains may “dry up” without “decisive action”.
And while prices and security may be of greatest concern in AR5, it’s clear the industry wants to make sure investment is secured for the long term, not just the next auction round.
The CfD application window is planned to run from 30 March until 24 April 2023, with results arriving sometime between July and September.